The concept of multitasking, for a person, is a myth. When someone says they are multitasking, they are quick task shifting. We can move our attention quickly from one task to the next, and shift back again, but it’s practically impossible to focus on two different things at the same time. To excel at anything requires undivided attention. Just ask an athlete who performs at world-class levels; the intense focus required to achieve at high levels doesn’t allow for multitasking.
It doesn’t take an Olympic athlete’s training and dedication to be successful when paying off debt, though. A solid debt repayment plan does not require 100% of someone’s focus. Should is require 100% of someone’s cash flow, though? To focus on paying off debt, should households suspend other financial goals like saving for retirement and setting up an emergency fund?
Saving in an emergency fund
An emergency fund is so important that it should be at least started before embarking on a plan to aggressively pay off debt. Without an emergency fund, if an emergency were to befall a household while all extra cash is designated for paying off debt, the only option for meeting the needs of that emergency might be going further into debt. With an emergency fund, you may have delayed the target date for being fully debt-free, but if an emergency occurs you’ll be able to handle at least part of the financial problem. A cash cushion will make paying off debt easier and will reduce stress levels.
If you can save just $1,000 in a high-yield online savings account, you’ll start a debt reduction plan from a much more stable position. It would be even better to have one month’s expenses saved away, with the rule that these funds would not be touched unless faced with a true emergency. Although the Debt Snowball and the Debt Avalanche prescribe putting all extra cash flow to paying off debt, establishing an emergency fund should be a parallel goal.
Saving for retirement
Saving or investing for retirement should, for the most part, be not put on hold, either. Don’t decrease your 401(k) contribution with the intent of putting extra money towards debt. You should invest enough to take advantage of any company match, because that could be an automatic 100% return for your money, and you can never get that back if you skip it. 401(k) contributions are tax deductible, another benefit you’ll lose if you reduce your contributions.
If your debt load is significant and ceasing your retirement contributions is the only way you could just meet your minimum payments, it may be justified to forego the benefits of investing in a 401(k) in favor of defaulting on your debt. However, in most cases, you should be able to keep your retirement investing steady., and any raises or bonuses you receive, sometimes automatically invested for the future, should be used for accelerating your debt payoff.
Saving for other goals
Saving for other purposes, like buying a house, paying for your children’s education, or taking a vacation next year, can be important, but paying off debt is a primary goal that outweighs other savings. These are “wants” or luxuries. Paying off debt is a necessity for having a financially independent life. You can delay buying a house, postpone a vacation, or even find different ways to fund college tuition.
To seriously take on the goal of paying off debt and to have an expectations of results, it’s imperative to put aside unnecessary desires and focus on the task at hand. For the last ten years, a friend of mine has been trying to get out of debt, or at least she says she has been. Yet, she continues to make life choices that involve spending more money than she has, and always has an excuse ready to go to justify the decisions in her own mind. I don’t judge people for their choices. I’ll support all friends in the way they choose to live their lives, but she might be happier in the long run once she decides to seriously prioritize getting out of debt.
Making sacrifices is never fun, and it’s easy to feel that middle class consumers deserve certain luxuries like television, Internet access, and cellular phone service. Many middle class consumers consider these to be necessities and wouldn’t dare cutting them from their lives, but if the trade-off is spending the rest of their lives indentured to credit card issuers and other lenders while leaving their income generation possibilities up to the whim of an employer, a few sacrifices today will make life better in the future.
“Earning” your debt interest rate
This doesn’t address the financial return of saving and investing for the future. It’s common to say that paying off debt is a guaranteed “return on investment.” That is, if you are paying off debt with an interest rate of 15%, you “earn” 15% by paying it off faster. Then, this fake ROI is used as a reason for prioritizing debt repayment above investing. The interest rate you “earn” for paying off debt is compared with expected return from investing to determine which approach should have priority. A 15% APR debt should be paid off before investing in the stock market with a 6% to 8% long-term estimated return, and investing in the stock market should be prioritized above paying off a 3% APR loan.
This is absolutely the wrong terminology to use. Debt is a result of spending money. You’re earning nothing by paying off debt, you’re spending less. You’ve already spent more than the value of the items you purchased with debt, so all you’re doing by paying off debt faster is cutting your losses. It’s important to do this, but you’re not earning anything like you would, potentially, with an investment.
Nevertheless, the interest rate comparison is fine for prioritizing debt. Unless you have a spending problem, it makes sense to hold onto a 0% APR balance as long as possible, but something like an emergency fund should not be looked at as an investment or compared to paying off debt. Assume money in a savings account earns a 0% return, but recognize that the importance of having the cushion ready to supplement your income with the loss of a job or an unexpected medical expense.
What changes would you make to your spending and saving plan if you decided to accelerate your debt payoff plan?
Published or updated August 29, 2011.
{ 12 comments… read them below or add one }
I prefer to concentrate my efforts on one or two goals in order to amplify the savings (or debt reduction). If I had high interest credit card debt I would focus all my energy on paying that off, even at the expense of an emergency fund.
The only savings that I would keep going would be the employer match in my retirement account (as you mentioned). That is free money that you shouldn’t be turning down.
Sometimes we spread ourselves too thin trying to do too much at once ($100 here, $100 there) and I think that psychologically we feel like we’re spinning our wheels and not making any significant gains anywhere.
I pondered that question for a long time… so first, I continued making presnowball (min. payments) on my debt, saved up my Emergency Fund to 1K – that happened quick. Then continued to put a smaller portion into my savings while ‘snowballing my debt’. I did cut my investments down, but did not stop.
Meanwhile I found ways to increase my income. If a raise, it went into my retirement account. Thus increasing my savings/investments again. If I sold something or received $ from affiliate blog sales…1/2 of that amount went to pay off my debt.
After I paid off a few bills on my snowball schedule (what worked for me), I actually increased retirement savings again. And increased the cash savings for my EF.
My answer…in the beginning it might do well to cut down or momentarily stop the savings/investing. But only for a short time, less than 3-6 months.. Because you never know what may happen in your life. Be safe.
Have a goal – debt paying schedule, stay focused and disciplined. You’ll find, and may be surprised, to find the positive money flow that comes your way. You’ll have no problem saving/investing/paying off debt all at once.
I know..but some may argue about the debt interest out weighing the savings interest. And that is why you should stop saving/investing while debt repaying. But to me…I want my family to be covered if something happened to me and to know I didn’t miss out on saving for retirement while I was paying off debt (especially since this debt repayment is a multi-year plan).
K…sorry so long. ;)
Yes, I think both are equally important. It isn’t easy,though.
“…all you’re doing by paying off debt faster is cutting your losses.” – well said. So very true!
I agree that it’s important to keep this is mind. Especially when the idea that paying off debt is like getting and immediate return of whatever the interest rate exists on the debt is so prevalent. People always need to do a simple cost benefit analysis when they are making any financial decisions, but the majority of us don’t know how to even start doing that.
I tend to agree with this article on virtually all of its points.
The lack of an emergency fund will hurt when it comes to an issue that can be resolved without furthering your debt obligations. At least $1000 is necessary, but one month’s salary will offer more stability.
Contrary to what the Debt Snowball preaches, I agree with contributing to a 401k with a match. If there is no match, a 401k is much worse than a Roth IRA.
Plus it makes sense to find the right strategy. Sometimes mixing strategies will work best.
Great article. It is really important to have some sort of emergency fund while paying off debt. I would say $1,000 should be the minimum. If you don’t save an emergency fund, and one comes up, uh-oh, you’ll be racking up more debt.
A few bad days can easily add up to $1,000. I think we all know when something breaks on a car, something else isn’t far behind it. And, if you have another car something will break on that too.
I would definetly save for an emergency fund or else the very thing you mentioned would happen when you needed extra finds when the car tore up, the child or yourself is sick, a snow day or flood dispurted work and you do not get paid for those days. Then you have no money for the emergencies. I am not so hard core on the retirement fund since to an extent it can be made up when out of debt. I know that you miss out on the compounding interest but you also miss the interest payment that are on the credit card when used.
I can’t pay my rent with a credit card. That’s why I’d want an EF even if I were repaying consumer debt. If I were to lose my job, without cash I’d be homeless fairly quickly.
Sure, I could take out a cash advance…ouch. Would much rather have an EF (and try to leave it right where it is).
Each person has to make their own decision. We chose to forgo retirement (no match available) but plan to revisit that since my new job has a 4% match. We also chose to forgo an emergency fund until credit card debt is taken care of. We’ve only had 1 emergency that did temporarily increase credit card debt (a car accident) buying new car seats and some medical costs while waiting on insurance reimbursement. We expect to have the credit cards paid off by the end of February. We felt getting out of debt sooner as more important than the emergency fund and still feel that way after an emergency.
My brother and his wife (who were also in the accident) are maxed out on their cards and would have done better to have an emergency fund (and a budget – topic for another day) than paying down debt. They still just look at what they can afford monthly and spend back up to the card maxes when they pay them down.
The article has answered the question, “Which comes first…the chicken or the egg”. Thank you for clearing this up. I did things the way you suggested, and it has worked well for me.
Flexo – always a big fan of your articles!!!
Love him or not, Dave Ramsey also preaches about starting with a $1,000 emergency fund before starting a debt payoff plan. What he also preaches, however, is that the interest rate argument never takes RISK into account. Sure, investing at 6% instead of paying off 3% debt makes sense on paper…until 2008 happens, your investments LOSE money and your job gets downsized. At that point, you’ll be making deals with the devil for a “do-over” to become debt free instead.